Australian income seekers need to know about dividend investing as it could be the best way to generate cash flow from investments.
For readers who don't know what a dividend is, it's when a company pays out some (or all) of the profit to shareholders. If the company hasn't made a profit this year and has no retained profit from previous years, then it can't pay a dividend.
There are two main reasons why I think ASX dividend shares could be a great option.
Better yield
Interest rates have increased significantly, so investors can now get a stronger return from cash, bonds and some other assets. But, I still think dividends are better.
There are numerous ways to invest for generating interest, but let's look at two ideas on the ASX.
Betashares Australian High Interest Cash ETF (ASX: AAA) gives exposure to a variety of cash deposits from a mixed group of banks. It has a current interest rate of 4.45%.
The Vanguard Australian Government Bond Index ETF (ASX: VGB) gives exposure to a portfolio of bonds from a variety of different Australian government entities. It has a yield to maturity of 4.40%.
Private commercial property can offer a better gross yield, but debt now costs a lot more (which reduces the rental profit) and there could be a reduction in property values because of the impact of higher interest rates.
Dividends are not guaranteed, but some dividend yields can be very pleasing. The yield is determined by a combination of the dividend payout ratio and the valuation (like the price/earnings (P/E) ratio).
Some ASX dividend shares can offer very good dividend yields, though exceptionally higher yields aren't necessarily better for longer-term dividend income. As a bonus, dividend investing Aussies can benefit from franking credits which can provide an after-tax boost to Australians after doing their tax return.
Using their FY23 payouts, Telstra Group Ltd (ASX: TLS) has a grossed-up dividend yield of 6.1%, Wesfarmers Ltd (ASX: WES) has a grossed-up dividend yield of 4.8%, Coles Group Ltd (ASX: COL) has a grossed-up dividend yield of 5.8% and Medibank Private Ltd (ASX: MPL) has a grossed-up dividend yield of 5.9%.
There are other bonds with higher yields, but they lack the second key reason why dividend investing can work well for ASX income seekers.
Growth
One of the best reasons to like ASX dividend investing in shares is they can achieve profit growth.
A company will do its best to grow its profit over time. Last year's profit enabled the latest dividend payments, and if a company can increase its profit, it can pay a bigger dividend the following year.
Higher profit may also mean investors value that business more highly, sending the share price higher.
A good business can pay dividends, grow the dividend over time and deliver capital growth for shareholders.
An Australian income-seeker can spend their entire dividend payment and still get a bigger payment next time (or reinvest it and supercharge the passive income growth).
Savers with money in the bank have to keep the interest generated in the bank to earn more next time, while bonds don't grow profit (except for interest rate changes).
Companies like Wesfarmers, Sonic Healthcare Ltd (ASX: SHL) and Brickworks Limited (ASX: BKW) have a history of growing their dividend regularly, though growth isn't guaranteed. There are plenty of other ASX dividend shares out there with good records.
